May 3, 2008 3:56 PM PDT

Why Microsoft covets Yahoo

Posted by Dan Farber

At the close of the 20th century and the beginning of the 21st century, the tech industry experienced a massive consolidation, culminating 40 years of market and technology development, from the mainframe to client/server computing and now the Internet.

Since 2005, Oracle made more than 40 acquisitions, totaling more than $20 billion. Microsoft, IBM, HP, Sun Microsystems, and Cisco Systems have each made dozens of acquisitions in the same time frame.

Consolidation is a sign of the mature phase in an industry, in which the biggest players stake out more territory as a way to increase share of wallet from customers by fusing together more complete solutions. It's the proverbial "one throat to choke" approach to enterprise computing.

In the Internet era, the consolidators want to be the data center infrastructure providers to the giant Web colonizers--Google, Yahoo, Microsoft, AOL, eBay, Amazon, etc.

The commercial Internet is relatively young, rearing its head with Netscape in the mid-1990s. But consolidation is already taking place, driven by Google's meteoric rise with search and advertising revenues. Instead of one throat for CIOs to choke, the Internet giants aspire to dominance in online ad serving and want to serve as the home base for billions of Web users on the planet.

For starters, the big advertising networks have been scooped up. Google paid $3.1 billion for DoubleClick, and Microsoft picked up aQuantive for $6 billion in cash. Microsoft's lust for Yahoo is in a similar vein. Google has 60 percent share of search market, and it keeps growing, and a Microhoo is the best offense from Microsoft's point of view.

CEO Steve Ballmer understands that Microsoft's dominance, gained primarily in the 20th century, is eroding. While Microsoft revenue continues to climb across its various business units, it trails in the online world. And, the online world of ads and subscription services is the future engine of growth and prosperity.

In the most recent quarter Google has $5.19 billion in revenue from its ad and search business. Microsoft had less than $1 billion for its entire online business, and Yahoo less than $2 billion, including a $401 million gain from its Alibaba investment.

In his talk with Microsoft employees on May 1, Ballmer said:

The future of the way people consume information, the way people socialize and connect is going to change a lot more in the next 10 years even than in the last 10. How you find information, how you consume it, how you share it and connect with your friends while you're in the middle of that, how it gets paid for using advertising and other techniques, dramatic changes. We are absolutely committed to be the leading player in that endeavor.

We are not today the leading player. We are not irrelevant, but we are not the leading player. We're committed to go do that.

Yahoo would add scale and expertise to Microsoft's online initiatives, and some interesting ways to build a social layer into the Microhoo fabric of somewhere between 600 million and 800 million unique users (which will certainly get flagged by regulators if the deal happens). The alternative for Microsoft is to go it alone, but that strategy so far hasn't yield the desired results. Hence, the consolidation route.

In this saga, it's difficult to tell who is the white knight for whom. The two companies are concerned about the Google juggernaut. But Yahoo is considering getting in bed with Google, allowing its rival to sell ads on its service, as a way to avoid Microsoft's embrace. On the other hand, Yahoo appears to welcome Microsoft's embrace for the right price.

But the deal has to be based on more than just price. If they don't get along and share the same vision, they will both suffer the consequences of a bad marriage, and Google wins anyway.